Whole life insurance is one type of permanent life insurance that can provide lifelong coverage. It provides a variety of guarantees, which can be appealing to someone who doesn’t want any guesswork after buying life insurance.
Whole life insurance combines an investment account called “cash value” and an insurance product. As long as you pay the premiums, your beneficiaries can claim the policy’s death benefit when you pass away.
Whole life insurance offers three kinds of guarantees:
A guaranteed minimum rate of return on the cash value
The promise that your premium payments won’t go up
A guaranteed death benefit that won’t go down
While it can sound like a good choice, there are often better options for individuals who want insurance that will last as long as they live.
Whole life insurance offers coverage for the rest of your life and includes a cash value component that lets you tap into it while you’re alive.
Whole life insurance is more expensive than term life insurance because people with a whole life policy are guaranteed to have a death benefit when they die. Term life insurance, on the other hand, offers level rates for a specific period, such as 20 or 30 years. Term life policies are cheaper than whole life insurance because they offer only coverage and no cash value.
Cash value accumulation in whole life insurance
Part of the premium payments for whole life insurance will accumulate in a cash-value account, which grows over time and can be accessed with a policy loan or withdrawal.
Similar to a 401(k) or IRA, the money in the cash value account grows tax-free. However, if you take out cash value that includes investment gains, through a policy withdrawal or loan, that portion will be taxable.
The accumulation of cash value is the major differentiator between whole life and term life insurance. While actual growth varies by policy, some take decades before the accumulated cash value exceeds the number of premiums paid. This is because the entire premium does not go to the cash value—only a small portion. The rest goes to paying for the insurance itself and expense charges.
Most whole life policies have a guaranteed return rate at a low percentage, but it’s impossible to know how much your cash value will actually grow. That’s because most insurance companies that sell whole life also offer a “non-guaranteed” return rate of return based on dividends. You can choose to apply your dividends to cash value every year, but you can’t know how much that will amount to overtime.
It may take decades for a policyholder’s cash value to exceed what’s paid in premiums.
Using the cash value in whole life insurance
You can tap into cash value with a withdrawal or a loan, or also by surrendering the policy. If you take a loan, it’s tax-free, and you can pay it back, with interest. There are no taxes as long as your withdrawal is less than the portion of your cash value that’s attributable to the premiums you’ve paid. If your withdrawal is greater, you’ll owe taxes on the difference because those are investment gains.
Outstanding loans and withdrawals will both reduce the amount of death benefit paid out if you pass away. That’s not necessarily a bad thing. After all, one of the reasons to buy a whole life insurance policy is to get cash value, so why let the money sit there without ever using it?
You want to be sure that you know all the ramifications of accessing cash value prior to making any decisions.
Death benefit and picking beneficiaries
When you buy a policy, you’ll choose a life insurance beneficiary to receive the death benefit. You don’t have to split the payout equally among beneficiaries. You can designate the percentage for each, such as 75% to Mary and 25% for John.
It’s also a good idea to designate one or more contingent beneficiaries. These folks are like your backup plan in case all the primary beneficiaries are deceased when you pass away.
Designating beneficiaries is an important task, as is keeping your designation up to date with your wishes. The life insurance company is contractually obligated to pay the beneficiaries named on the policy, regardless of what your will says. It’s wise to check once a year to verify your beneficiaries still reflect your wishes.
What happens when you die
A major selling point of whole life insurance is that it will be in force until your death, as long as you’ve paid the required premiums.
But here’s a kicker: For most policies, the policy pays out only the death benefit, no matter how much cash value you’ve accumulated. At your death, the cash value reverts to the insurance company. And remember that outstanding loans and past withdrawals from cash value will reduce the payout to your beneficiaries.
Some policies allow you to purchase a rider that gives your beneficiaries both the death benefit and the accumulated cash value. This provision also means you’ll pay higher annual premiums, as the insurance company is on the hook for a larger payout.
How Much Does Whole Life Insurance Cost?
While some of the cash value features and the permanent nature of whole life insurance sound appealing, whole life insurance is simply unaffordable for many people.
Many life insurance shoppers look at term life vs. whole insurance costs. It’s never an apples-to-apples comparison because the policies are so different. That said, here are examples of whole life insurance quotes based on a 30-year-old male of average height and weight for $500,000 in coverage.
Type of life insurance
20-year term life
30-year term life
This cost differential makes whole life insurance far less attractive to many individuals with an insurance need.
Here is a life insurance calculator to help you determine your life insurance need.
Factors that affect whole life insurance premiums
The coverage amount you choose will help determine your rate, along with:
Age and gender
Height and weight
Past and current health conditions
The health history of your parents and siblings
Nicotine and marijuana use, including nicotine patches and gum
Driving record (especially DUI convictions and moving violations, such as speeding tickets)
Dangerous hobbies and activities (such as piloting planes or rock climbing)
With whole life insurance, there are a variety of other features and provisions that can affect costs as well, such as:
Payment period: You can choose to pay for the entire policy in a short time frame, such as 10 or 20 years. The premium would rise substantially given the front-loading of payments.
Guaranteed return rate: Some companies offer a higher guaranteed return, which can result in higher annual premiums.
Dividend crediting: Many whole life policies pay out a dividend, and policyholders can choose how to receive it. Receiving your dividend payments as a credit toward premiums reduces your annual out-of-pocket cost.
Related: Best Life Insurance Companies
Options for Surrendering Whole Life Insurance
With term life insurance, if you no longer have a need for insurance, you can simply stop paying. Once you stop, the policy lapses and the insurance company will no longer pay any benefit if you pass away.